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Posted on: Wednesday, March 23, 2005

Fed hikes key rate to 2.75%

By Sue Kirchhoff
USA Today

WASHINGTON — The Federal Reserve boosted a key short-term interest rate yesterday and signaled that additional increases are needed to contain rising inflation pressures.

The Fed's policy-making Open Market Committee raised its target for short-term rates to 2.75 percent from 2.5 percent, the seventh straight quarter-point increase since June.

In a statement, the policy-makers said they expect to keep raising rates at a "measured" pace. But in a twist that rattled financial markets, they noted warning signs of inflation.

"Though longer-term inflation expectations remain well contained, pressures on inflation have picked up in recent months and pricing power is more evident," the Fed said, though adding that higher energy prices had not pushed up core consumer prices — products other than food and energy.

In Hawai'i, First Hawaiian Bank, Bank of Hawaii and American Savings Bank responded to the Fed's move by announcing that they would raise their prime lending rate to 5.75 percent from 5.5 percent effective today.

Although calling the statement hawkish, economists still generally expected the Fed to keep raising rates in quarter-point increments, including at the next policy meeting May 3. But they said the central bank is clearly prepared to act more aggressively if needed to tamp down inflation, or could raise rates for a longer time.

"While the Fed has opened the door to a policy stance that is far less friendly to the economy, they clearly do not contemplate moving there in a rush," said Charles Lieberman, managing member at Advisors Capital Management.

Bond prices fell and yields soared after the statement on inflation, while the Dow Jones industrials average fell 95 points to 10,471.

Since the Fed last raised rates in February, crude oil prices have soared nearly $10 barrel.

Also yesterday, the Labor Department said wholesale prices rose 0.4 percent in February, as energy prices climbed 1.4 percent and food costs 0.8 percent. Core wholesale prices inched up just 0.1 percent but are up 2.8 percent in the past year, the biggest gain in a decade.

The Fed said output is growing at a solid pace despite higher energy prices, while the job market is gradually improving, indicating less slack in the economy.

In previous statements, the central bank has termed the risks to the growth balanced between higher inflation or slower growth. This time, Fed officials said the risks should remain roughly equal if the Fed implements the appropriate interest-rate policy.

Short-term rates, which stood at 1 percent before the Fed started raising them in June, are the highest since fall 2001. But the Fed said rates are still stimulative.

In a note to clients, UBS Securities economists predicted the Fed will continue with quarter-point increases and that short-term rates will reach 4 percent by the end of 2005.